BRUEGEL

POLICY
CONTRIBUTION

REFORM OF THE
ISSUE 2011/03
MARCH 2011

INTERNATIONAL
MONETARY SYSTEM:
SOME CONCRETE STEPS

AGNÈS BÉNASSY-QUÉRÉ, JEAN PISANI-FERRY AND YU YONGDING

Highlights
• Reform of the international monetary system is under discussion after
three decades of apathy. However, in the short term, there is little chance of
a grand redesign. Nevertheless, concrete steps should be taken.
• First, consensus is needed on exchange rates, capital flows and reserves.
This consensus is closer than often assumed, and should be codified in
some form of soft law, with provisions for surveillance agreed on.
• Second, financial safety nets must be improved so that countries do not
have to self-insure by accumulating reserves. The least difficult route could
be a new regime for deciding on Special Drawing Right allocations that
would facilitate more frequent use of this instrument.
• Third, a change in the composition of the SDR should be planned for, to
strengthen the multilateral framework by including the renminbi. These
reforms would be a partial move, and would prepare the ground for further
Telephone
+32 2 227 4210 developments.
info@bruegel.org

www.bruegel.org This paper was prepared for the Brookings Institution’s Think Tank 20 project.
Agnès Bénassy-Quéré is Director of CEPII (Centre d'Etudes Prospectives et
d'Informations Internationales). Jean Pisani-Ferry is Director of Bruegel. Yu
Yongding is President of the China Society of World Economics and Academician,
Chinese Academy of Social Sciences (Beijing).
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REFORM OF THE IMS • Agnès Bénassy-Quéré, Jean Pisani-Ferry and Yu Yongding
02
REFORM OF THE INTERNATIONAL MONETARY
SYSTEM: SOME CONCRETE STEPS
AGNÈS BÉNASSY-QUÉRÉ, JEAN PISANI-FERRY AND YU YONGDING, MARCH 2011
THE POSTING OF Governor Zhou Xiaochuan’s
famous paper1 in 2009 awakened the debate on
the international monetary system (IMS) from a
three-decade long state of apathy. In the run-up
to the 2011 French presidency of the G20, many
ideas were floated about reforming the interna-
tional monetary system, through reports, papers
and conferences. These contributions pointed out
in particular the deficiencies of the present
system: dependence on a key reserve currency,
which in turn leads to asymmetries in the process
of adjustment; inability to provide incentives for
surplus countries to adjust; disregard for spillovers
effects of national monetary policies and, as a
result, the possible inadequacy of the global mon-
etary stance; the costly reliance on self-insurance
through reserve accumulation on the part of
developing and emerging countries; inability to
channel net capital flows from low-return,
advanced economies to high-return, emerging
countries; and significant real exchange-rate mis-
alignments, sometimes leading to 'currency wars'.
Old policy dilemmas, such as that of Triffin, have
been revisited, and old ideas, such as the expand-
ing the role of the Special Drawing Right (SDR),
have been intensively discussed.
The need for a change in the international mone-
tary system – what Keynes famously called the
“rules of the game” – is accentuated by tectonic
shifts in the balance of international power. These
shifts were already visible in the last decade, but
the financial crisis and its asymmetric effects on
advanced and emerging countries have acceler-
ated them. By 2020, the balance of economic
1. Zhou Xiaochuan (2009)
'Reform the interna- power globally will be more equal than at any time
tional monetary over the last two centuries, and there is therefore
system', available in BIS a strong case for moving towards a multipolar
Review 41/2009,
http://www.bis.org/revie monetary system whose main planks are likely to
w/r090402c.pdf. be the US dollar, the euro and the renminbi.
In the short term however, there is no hope of
rebuilding the international monetary system
according to any of the grand designs on offer. The
weaknesses of the euro and the renminbi are too
apparent for these currencies to constitute alter-
natives to the US dollar. To reform the rules of the
game is an ambitious enough endeavour. To
rewrite them entirely, as some proposals suggest,
is not on the agenda. We are not in 1944.
It is therefore time to focus the debate on what is
possible. Already, official working groups have
been tasked with providing concrete proposals for
the G20, to be discussed at the finance ministers'
meetings, in readiness for decisions to be taken
at the heads of states and governments G20
summit in Cannes, in November.
So what could the concrete steps be? What are
the reforms that would both help address funda-
mental deficiencies and command a sufficient
degree of consensus? We suggest three avenues:
• First, to create consensus on policies on capital
inflows and provide a framework for interna-
tional surveillance of national capital controls,
reserves and exchange rate policies. This would
help tackle the risk of 'currency wars'.
• Second, to draw on the results of the Korean
G20 presidency in 2010 and strengthen finan-
cial safety nets so that countries do not have
to self-insure by accumulating reserves or to
rely on possible bilateral swap lines to access
liquidity when confronted with sudden stops.
• Third, to prepare and plan for a change in the
composition of the SDR, that would strengthen
the multilateral framework while favouring evo-
lution towards a more multipolar system.

Agnès Bénassy-Quéré, Jean Pisani-Ferry and Yu Yongding • REFORM OF THE IMS
‘Exchange rates, capital flows and reserves are highly controversial. But it is apparent that the
crisis has had highly asymmetric effects that call for a real exchange rate realignment between
the advanced and emerging worlds. This realignment will take place one way or another.’
EXCHANGE RATES, CAPITAL FLOWS AND
RESERVES
The first topic seems highly controversial at first
sight because it touches on the sensitive issue of
exchange-rate policies. But it does not need to be
controversial. To start with, it is increasingly
apparent that the global crisis has had highly
asymmetric effects that call for a real exchange-
rate realignment between the advanced and
emerging worlds. This realignment is going to
happen one way or another, either through nomi-
nal exchange-rate changes or through divergent
inflationary developments. Higher pressure on
consumer prices will reduce the willingness of
emerging country governments and central banks
to oppose exchange-rate appreciations through
reserve accumulation and/or capital controls.
For the same reason, the controversy about capi-
tal controls is abating. The International Monetary
Fund is less reluctant than in the past to make
room for such controls in the policymakers’ tool-
box. At the same time, it is increasingly recognised
by policymakers in emerging countries that capi-
tal controls are only one instrument among sev-
eral. They are part of a broad range of
macroeconomic and macro-prudential tools that
can be used to limit the detrimental impact of
large, volatile capital inflows.
Policy consensus may therefore be within reach.
What will be more difficult is to agree on institu-
tional arrangements. To start with, the emerging
international consensus should be written down
in some sort of soft law, such as a code of conduct.
Second, the joint monitoring of capital controls
and exchange-rate policies, with the aim of sepa-
rating macroeconomic and financial stability
motives from mercantilist motives, would need to
be allocated to an international body. This body
should provide assessments and policy
suggestions, as well as technical assistance when
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required. A natural candidate for this task would
be the IMF. However, this would require amending
the Fund’s statutes (since the IMF presently has
no legitimacy to review financial-account poli-
cies). Hence, a formal approval by 85 percent of
the board of governors would be needed. This is
not impossible, but is demanding in view of the
continuing lack of trust in the institution in signif-
icant parts of the emerging world.
FINANCIAL SAFETY NETS
To put in place financial safety nets, two different
routes may be taken: a strengthening of bilateral
central bank swap lines, and an extension of mul-
tilateral schemes. During the crisis, swap lines
generously extended by the US Federal Reserve
(and, to a lesser extent, other key central banks)
proved instrumental in providing US dollar liquidity
to national central banks. However these were uni-
lateral, discretionary initiatives, the benefits of
which were reserved to some partners and whose
repetition may not be taken for granted, should
another crisis hit.
One idea would be to institutionalise the network
of swap lines under the supervision of the IMF.
There would be a risk of losing in the process the
flexibility demonstrated during the crisis. Under-
standably also, and perhaps more importantly,
this project is vigorously opposed by central
banks, whose independence has already been
brought into question because of their role in
keeping ailing banks (or, in the European case,
states) afloat, the threat of a return of fiscal dom-
inance, and the extension of their mandates to
macro-prudential surveillance. Formal commit-
ments from central banks to extend swap lines to
countries designated by an international institu-
tion are unlikely in these circumstances.
The institutionalisation of bilateral swap lines
would also amount to the creation of a two-tier
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system in which countries would explicitly depend
on the support of regional partners. Such schemes
may be attractive to some countries where coop-
eration around a regional hub has developed, but
it can hardly provide a global solution.
This leads to consideration of potential multilat-
eral schemes. It is necessary here to distinguish
three variants:
i The pooling of central banks’ foreign-exchange
reserves, possibly with a transformation of part
of them into SDR reserves;
ii The creation of new IMF facilities;
iii A more active policy of SDR allocation, through
more frequent, possibly counter-cyclical and/or
targeted allocation by the IMF.
The pooling of official reserves has already been
practised at regional level and could conceivably
be extended to the multilateral level. While effi-
ciency-enhancing, this raises difficult questions
about the sharing of the exchange-rate risk and
about the use of the reserves. Reserve pooling
would require rules on how each member could
use these reserves, which would be difficult to do
ex-ante. Furthermore, access rules would make
reserve pooling inferior to unconditional self-
insurance through reserve accumulation.
IMF facilities are a way to channel reserves to
countries hit by capital outflows. The recent evo-
lution has been towards the creation of no-condi-
tionality (the Flexible Credit Line – FCL) or
low-conditionality (the Precautionary Credit Line
– PCL) facilities that aim at crisis prevention
rather than crisis management. Further proposals
have been put forward such as the Fund’s Global
Stabilisation Mechanism (GSM), a new mecha-
nism that would activate the provision of liquidity
to systemic and vulnerable countries in case of a
systemic shock. The problem with such facilities,
however, is that potential beneficiaries might
‘New SDR allocations would provide countries with SDR reserves that they could exchange for
currency reserves. In limited volumes such allocations would be unlikely to have far-reaching
consequences for global liquidity while providing a welcome buffer for vulnerable countries.’
remain unsure that they will get access to them
in times of need, which makes them partial sub-
stitutes to reserves only.
New SDR allocations would not have this short-
coming. They would provide countries with SDR
reserves that they could exchange for reserves
denominated in the currency of their choice. If pro-
vided in limited volumes and in response to
increases in the demand for reserves only, such
allocations would be unlikely to have far-reaching
consequences for global liquidity while providing
a welcome buffer for vulnerable countries. But to
make them a recurring feature of the provision of
liquidity, a revision of IMF statutes would be
needed (since currently an 85 percent majority
within the board is needed to decide an SDR allo-
cation). This avenue cannot be considered closed
but it presents serious hurdles.
A NEW SDR
Several SDR-based proposals are on offer. One aims
at addressing a different shortcoming of the IMS,
namely the lack of safe assets at global level. The
idea is to create a new investment vehicle by allow-
ing international financial institutions, including
the IMF, to issue debt securities denominated in
SDR. The liquidity of the SDR market could be
enhanced by developing the private use of the SDR,
through commodity invoicing and subsequent
demand for SDR-denominated bonds.
This is certainly not the only way to expand the
range of safe and liquid assets that is needed at
the global level. Another, which should be encour-
aged, would be the development of national-cur-
rency bond markets.
Although consistent with the initial purpose of the
SDR, from 1969, the promotion of SDR-
denominated securities through IMF borrowing is
likely to encounter a number of obstacles: notwith-

Agnès Bénassy-Quéré, Jean Pisani-Ferry and Yu Yongding • REFORM OF THE IMS
standing technical problems related to the initial
liquidity premium (estimated 80-100 basis points
by the IMF staff) and to the need for market infra-
structures for SDRs, IMF members are likely to be
reluctant to surrender to the oversight of the IMF
resources they currently enjoy.
Rather than trying to create an SDR market from
scratch, we suggest adapting the existing SDR to
the new global environment through more fre-
quent allocations, and by planning the inclusion
of the renminbi in the SDR basket (which
presently only includes the dollar, the euro, the
yen and sterling), in the context of an opening up
of China’s financial account and a move towards a
flexible exchange-rate regime in China. Such a
reform would be consistent with the rapid shift of
the global economy in favour of China. It would put
the largest reserve holder at the centre of the SDR
liquidity-provision system and would create a nat-
ural venue for monetary-policy dialogue and pos-
sibly coordination between the five countries
involved in the SDR – a G5 circle.
Interestingly, the renminbi need not be
immediately included in the SDR, and China need
not immediately open up its financial account, for
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China to play a part in providing financial safety
nets. The People's Bank of China has already
started extending swap lines to a number of for-
eign central banks in renminbi, in addition to the
Chiang Mai initiative. It could also provide liquid-
ity in dollars in exchange for a number of listed
currencies – say the currencies of the G20 – and
provide SDR-denominated loans. This would be a
way for China to diversify its reserves smoothly
while providing international liquidity in times of
stress, without having to wait for a move to free
convertability and integration into the multilateral
liquidity-provision scheme.
IN BRIEF, the most workable deliverables today
seem to be (i) guidelines on and surveillance of
capital controls, (ii) a new regime for deciding on
SDR allocations that would facilitate more frequent
use of this instrument, and (iii) the inclusion, after
some delay and against financial opening up, of
the renminbi into the SDR basket.
Would these three reforms be conducive to
addressing the shortcomings of the international
monetary system? Only partly. But they would
represent concrete steps towards change and
would pave the way for longer-term developments.